How America's Housing Non-Recovery Led To Record Income Inequality

With bond yields soaring over fears of a Fed tapering, and 30 Year fixed mortgages on the verge of crossing 5.00%, it is inevitable that any "speculative" investment property components, driven by cheap and abundant credit, to what continues to be incorrectly labeled a housing recovery, will crash and burn in the days and weeks ahead. This was already confirmed when looking at mortgage applications, which tumbled at the fastest pace in three years. However, as the following note from CLSA's Chris Wood explains, there is another angle when a housing recovery is not a housing recovery: a surging Gini coefficient. In fact as Wood observes that "the Gini coefficient had apparently reached in 2006 the previous high seen in 1929, prior to the Great Depression." In other words, the US now has greater income inequality than even during its worst economic episode in history.

This means, unfortunately, not that the problem has been avoided but that the ‘great reckoning’ has been deferred to another day as the speculative classes have continued to game the system by resort to carry trades actively encouraged by the Fed and other central bankers, which is why fixed income markets freak out when they see signs of an exit.

Precisely. It also means, even simpler, that the rich are getting richer, while the poor not only can't afford to buy homes, but are getting poorer by the day. For some colorful stories of what previous episodes of such unprecedented social divergence may ultimately leads to, just speak to France circa 1788.

From CLSA's Greed and Fear

If housing has staged an impressive pickup in activity, GREED & fear’s view remains that the recovery in American housing is different from a conventional recovery from a housing bust in that it has been jump started to a huge extent by massive investor demand in the context of the unusual circumstances provided by unconventional monetary policy, including the Fed’s buying of mortgage backed securities (MBS). The Fed’s holding of MBS totalled US$1.2tn at the end of June.

The degree to which yield-seeking investors, including specialised investment funds, have driven the housing recovery is best illustrated by the extent to which the new mortgage applications index has not recovered as much as say housing starts. Thus, the US new purchase mortgage application index has so far risen by 29% from its low reached in October 2011, while US housing starts are up 91% from their April 2009 low (see Figure 5). It is, therefore, necessary to continue to watch the new mortgage applications index closely for evidence that the baton in the housing recovery will be passed from investors to end buyers. In this respect, the obvious constraints on end buyers are a lack of income to service the mortgage and, more importantly, a lack of sufficient equity in terms of what is required by banks post-crisis to have a mortgage. Indeed there is a risk that investors, on account of still attractive rental yields compared to what is available in fixed income markets, keep pushing up prices so that houses become unaffordable again. Certainly, in GREED & fear’s view investors will be much less concerned by rising mortgage rates, courtesy of the recent Treasury bond sell-off, than would-be home owners.

The above thesis of an investment property boom, as opposed to a conventional housing recovery, raises another consequence of unconventional orthodoxy. This is that the practical way these policies work is to lead to ever more extreme wealth distribution, as reflected in America’s Gini coefficient which measures the degree of income inequality. The Gini coefficient has risen from 0.386 in 1968 to 0.47 in 2006 and was 0.477 in 2011, according to the US Census Bureau (see Figure 6). This is because the wealthy are geared into rising asset prices, particularly prices of financial assets, whereas ordinary people are geared into average hourly earnings growth. In this respect the Gini coefficient had apparently reached in 2006 the previous high seen in 1929, prior to the Great Depression. This is a reminder that capitalism’s natural way of dealing with excesses is via business failure and liquidation; which is why wealth distribution would have become much less extreme as a consequence of the 2008 crisis if losses had been imposed on creditors to bust financial institutions, for example owners of bank bonds, in line with capitalist principles; as opposed to the favoured ‘bailout’ approach pursued for the most part by Washington.

This means, unfortunately, not that the problem has been avoided but that the ‘great reckoning’ has been deferred to another day as the speculative classes have continued to game the system by resort to carry trades actively encouraged by the Fed and other central bankers, which is why fixed income markets freak out when they see signs of an exit. But the point to remember is that the leverage taken on in such trades is highly risky because of the underlying deflationary trend.

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Which is precisely why the Fed's pseudo-exit via hints of tapering is why the entire house of "housing recovery" cards is set to tumble any minute: because quite simply it was never a recovery to begin with, but merely the latest cheap credit-funded, hot potato flipping ploy conceived by the Fed to benefit its private bank backers. And, as always, it will be everyone else left to fund their bailout once this latest credit bubble pops and the TBTF card is used one more time...